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12 Int'l Fin. L. Rev. 35 (1993)
How to Negotiate the Tax Gross-up Clause

handle is hein.journals/intfinr12 and id is 469 raw text is: proper context. If a report is necessary, an effective strategy for disclosure to the government should be devised, for the manner and forum of a report can materially impact the outcome for the company. Internal investigations are often conducted by out- side counsel familiar with compliance laws and the law enforcement apparatus. The involvement of out- side counsel may improve the odds that the confiden- tiality and legal privileges attendant to the matter will be preserved. Further, a report stemming from an investigation conducted by outside counsel is likely to be accorded greater weight and may eliminate the need for, or at least reduce the scope of, an intrusive investigation by law enforcement officials into the reported incident and other business affairs. Finally, counsel may prove instrumental in advising the organization how best to present the matter to the appropriate government authorities so as to achieve the very objective which prompted corporate compli- ance in the first instance - the maximizing of credit to be received by the organization for its good corporate citizenship. U How to negotiate the tax gross-up clause Ask not for whom the tax roll calls. Lee C Buchheit of Clear3 Gottlieb, Steen & Hamilton, New York continues his series on negotiating skills with a look at the tax gross-up clause If you are a taxing authority, the only sin for which you can be held accountable (in this life) is lack of imagination. No aspect of the human condition, even the leaving of it, should be overlooked as a potential opportunity for levying a tax. And when the good peo- ple of Ruritania invoke the assistance of Our Lady of Lourdes to shield them from further plundering, don't worry. She probably won't appear and, on the off chance that she does, simply assess her the airport departure tax. The populace will get the message. A government that has run out of creative ideas for taxing its own citizenry should seriously consider tax- ing somebody else's citizenry. For the Republic of Ruritania, taxing foreigners has two inestimable advantages over taxing the natives: the foreigners aren't entitled to vote in the next election and you won't have to listen to that pathetic bleating that fol- lows each domestic tax increase. The problem, of course, is how to get foreigners to pay Ruritanian taxes. So many people these days cling to their money with an unseemly obstinacy. After sur- rendering most of their money to their own federal, state and local taxing authorities, foreigners may balk at handing over the last few coppers to the Republic of Ruritania. What is needed, therefore, is some plausible excuse for levying a tax on non-residents and, equally important, some effective method for ensuring that the tax will actually get paid. The conventional soluton is a withholding tax. It works like this: assume that a cash-strapped Ruritanian company doesn't fancy borrowing at the interest rates prevailing in the local capital market. One obvious alternative is for the company to sign up a loan with a foreign bank at an interest rate based, for example, on the US dollar London interbank rate. To the Ruritanian tax authorities, however, the stream of interest payments due to the foreign bank under this loan acts like a beckoning finger. By imposing a tax on these interest payments, Ruritania can achieve three important objectives. First, it taxes. Second, it levies the tax on a foreigner - the bank recipient - rather than the Ruritanian company (an ephemeral benefit, as described below). Third, it can collect the tax by forc- International Financial Law Review September 1993 ing the Ruritanian borrower to Withhold or deduct the amount of the tax from the interest payments due to the foreign bank. The buzzing fly in this ointment is likely to be the foreign lender. That institution may not relish the prospect of making regular contributions to the Ruritanian exchequer through deductions from the interest payments it expects to receive under the loan. Indeed, if it thought this consequence were unavoid- able, the bank probably wouldn't make the loan in the first place. As protection, the bank will look to a provi- sion in the loan agreement that goes by the name of the tax gross-up clause. Purpose of the clause The purpose of the tax gross-up clause is to shift to the borrower the risk that a withholding tax might be imposed on payments due under the loan. With- holding taxes are often expressed to be the legal responsibility of the recipient of the interest payment, not the payor. The gross-up clause requires that if ever such a withholding tax becomes applicable to pay- ments due under a loan, the borrower will pay that tax on the lender's behalf and will pay an additional amount to the lender (in the jargon, a 'gross-up' pay- ment) so that the lender will receive the precise amount that it would have received in the absence of such tax. Any deduction as a result of the imposition of withholding taxes thus becomes the borrower's responsibility because the borrower's payment to the lender must be topped up to compensate for the deduction. By the way of example, assume that the interest pay- ment due to the lender is $100 and the borrower's jurisdiction imposes a 30% withholding tax. By virtue of the tax gross-up clause, the borrower will be oblig- ated to pay $30 to the local taxing authority on the lender's behalf and then pay a full $100 to the lender (reflecting a $30 gross-up payment to compensate for the withholding tax). The score at the end of the first inning will therefore be: lender + $100; Ruritanian Internal Revenue Service + $30; and borrower - $130.

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